International Forecaster Weekly

Shoot Yourself in The Foot by Sanctioning Russia

Russia is starting to hit where it counts: the pocketbook of the average European. Russia is slowly turning off the natural gas spigot as shipments to Europe are down 4% from the previous week. And now Russian Gazprom is asking nearly $500/1000 cubic meters of gas, almost one third more than it charges other clients around the world.

James Corbett | March 26, 2014

As expected, the effects of the lightweight sanctions that have been placed on Russia by the US and EU so far have been mostly negligible. Reports of a slowdown in the Russian economy or a drop in the stock market are lacking context: Russian growth was already anemic before the Ukrainian crisis developed, on track for the worst performance since the 2009 recession on the back of a consumer slowdown and sagging investment. Any effects from the scattershot sanctions imposed on a few officials so far pale in comparison.

            Even one of the unexpected and potentially damaging spin-offs of the sanctions—MasterCard and Visa stopping processing for embargoed Bank Rossiya, Sobinbank, and SMP Bank—turns out not to be a huge deal. Moscow has been preparing its own homegrown electronic system for processing transactions with the government for years, and now that infrastructure can simply be converted to creating an in-country credit card system at the drop of a hat. According to Avivah Litan of Gartner Research: “If the banks are all on board, they can use the existing [card-reading] equipment in the retail stores. They’ve been thinking about it for so long, it’s just a matter of flipping the switch.” To add insult to injury, Visa just spent $40 million as an official corporate sponsor of the Sochi Olympics helping to upgrade the region's payment infrastructure.

            And now the inevitable retaliation is starting to take shape. Of course there's the (largely meaningless) sanctions that Russia has applied to a handful of US, EU and even Canadian officials as a tit-for-tat in this game of smoke and mirrors. But more importantly, Russia is starting to hit where it counts: the pocketbook of the average European. Russia is slowly turning off the natural gas spigot as shipments to Europe are down 4% from the previous week. And now the NY Times is reporting that Russian Gazprom is asking nearly $500/1000 cubic meters of gas, almost one third more than it charges other clients around the world. In other words, they're starting to turn the screws. Perhaps even more worryingly for the NATO-backed Ukrainian coup government, Russia is now demanding payment of $11 billion for a 2010 agreement that no longer applies (Russia agreed to a natural gas discount for Ukraine in exchange for an extension of their Crimean naval base).

            And the other side of the sanctions is that Russian investment and tourism to Europe (and of course the US) will both fall as an inevitable result of this course of action. In fact, an easing of tier-one visa regulations in the UK (so-called “investor” visas) meant that a lot of hot Russian money flowed into the country over the last several years. Russians were the number one recipients of the visa in the 5 year period from 2008 to 2013 and accounted for a significant percent of the London property boom and high-end retail sales. But although February 2013 saw a 16% year-on-year rise in the amount of money Russian visitors spent in the UK, the February 2014 numbers show a 17% year-on-year drop. Expect similar numbers around the region and an end to the inflow of hot Russian investment funds into Europe if the sanctions war escalates.

            So take the G-7's “dramatic” talk about sanctions with a grain of salt. Either they're lying about wanting to expand the sanctions or they're trying to shoot themselves in the foot. Either way, Europe is likely to come out from this about as worse for wear as the Russians do, and for every sanction they slap on Russia they pound one more nail into the coffin of the petrodollar as the world reserve currency. After all, there's nothing like an economic iron curtain to encourage Russia to form a local currency trading bloc with its neighbors and allies.